Putting a Price on the Value of Bitcoin

May 25, 2018

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Bitcoin specifically, and cryptocurrencies in general, have garnered significant headlines recently for their extreme price volatility. Increasing from $1,700 in May 2017, to a high of over $19,000 in December 2017 before dropping back down to $7,000 in April 2018, some Bitcoin investors saw gains of 1000% while others saw losses of 70% within the past 12 months.

As cryptocurrency mining and investing becomes more popular, we are getting more requests to value businesses that own cryptocurrency. Since there currently is a market for cryptocurrencies, we are able to look up the trading price to find its value. But is it really that easy? Are there situations when price and value are different things?

The debate of price vs. value is not new and certainly is not limited to cryptocurrency. You will often hear business owners, investors and analysts give their opinions of whether a public company’s stock price is over or under “valued”. Talk about the price of real estate to anyone living in Vancouver and you will hear very strong opinions on whether the market is over-valued and ready for a crash or appropriately valued and sustainable.

So why does this debate exist? While prices paid for an asset can be observed through actual transactions, value can be much more subjective depending on one’s perspective. I suppose that is why they call it a valuation “opinion”. In times like this, we are reminded of Warren Buffet’s famous quote:

“Price is what you pay, value is what you get.”

In the context of a business valuation, we use the following definition to define fair market value:

The highest price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

So how exactly does this definition impact our valuation of cryptocurrency? The link within the definition is the trading price being a strong indicator of value (i.e., the highest price between a willing and able buyer and seller, acting at arm’s length when neither is under compulsion to buy or sell). These are all characteristics of the observable trading prices at any given point in time.

However, the two parts of the definition that are up for debate are whether it is an “open and unrestricted market” and whether the parties have a “reasonable knowledge of the relevant facts”.

Depending on what side of the fence you sit on, you could make an argument either way. On one hand, the theory behind the underlying blockchain technology is the ability to create an open, transparent system that is free from manipulation. On the other hand, many of the people investing in Bitcoin likely did not understand or care about the fundamental value of Bitcoin and instead were taking actions based on speculation of market price trends. There is no single, coordinated exchange for cryptocurrencies, so a single Bitcoin could trade for different prices depending on the exchange, and these exchanges are not regulated in the amount of information they are required to provide on each trade.

Inherent in the concept of fair market value is the expectation that the value is justifiable and sustainable over a period of time based on its fundamental investment principles. The extreme volatility of Bitcoin’s trading price is a sign that speculators have a strong influence on price. As Bitcoin, and cryptocurrencies in general, are still relatively new and not well understood by the general public, it is difficult to assess its true fundamental value which is based on the potential to disrupt traditional currencies. If Bitcoin becomes more mainstream and widely understood, we expect prices to stabilize with investors, meaning that buy/sell decisions will be based on an actual understanding of Bitcoin’s value.

If you would like to discuss the value of Bitcoin or other cryptocurrencies further, please get in touch with one of our Chartered Business Valuators.